Your donation keeps us advertisement free


New York Supreme Court Dismisses All but One Claim in Suit Brought by Facebook Purchaser

In Facie Libre Assocs. I, LLC v. Secondmarket Holdings, Inc., No. 651696-2011E (N.Y Sup. Ct. August 10, 2012), the New York Supreme Court granted defendant SecondMarket Holding’s (“SecondMarket”) motion to dismiss on all but one claim.  Plaintiffs, Facie Libre Associates I, LLC and Facie Libre Associates II, LLC (collectively “Facie Libre”), which is coincidentally Latin for “Facebook,” were Delaware LLCs organized for the purpose of buying shares of Facebook before it went public.  SecondMarket created an online marketplace and brought together buyers and sellers of shares in privately held companies.  Facie Libre brought claims against SecondMarket for breach of contract as a third party beneficiary, negligence, breach of fiduciary duty, intentional misrepresentation, professional malpractice and unjust enrichment.

According to the complaint, the dispute arose when a Facebook employee sought and was granted permission from Facebook to sell 75,000 Class B common shares.  The employee entered into a Stock Transfer Agreement (“STA”) with Facie Libre that valued the shares at $33 per share for a total purchase price of $2,475,000.  SecondMarket entered into an Intermediary Services Agreement (“ISA”) with the Facebook employee whereby SecondMarket would design, implement, and facilitate the entire transaction in exchange for $75,000. 

Facie Libre alleged that SecondMarket had a duty under the ISA to deliver a legal opinion and obtain Facebook’s signature to authorize the transaction.  This task needed to be completed by a deadline of March 26, 2010.  Facie Libre’s expectations were based on twenty previous transactions with SecondMarket in the past. 

Three months after SecondMarket represented to Facie Libre that the transaction had closed, SecondMarket recanted and revealed that it had failed to present Facebook with the legal opinion by the deadline and that the transaction never closed.  Shortly after the missed deadline, Facebook instituted an insider trading policy that prevented employees from selling shares to company outsiders.

SecondMarket initially sought dismissal of  the claims based on a one-year limitation of liability provision in its User Agreement and the argument that the User Agreement barred liability on the claims in this case.  The court rejected both arguments because the User Agreement governed use of SecondMarket’s website, while the STA governed the transaction.

Facie Libre’s breach of contract claim was dismissed because the agreement at issue was not breached.  To succeed as a third-party beneficiary of a contract, the plaintiff must establish that (1) a contract existed between other parties; (2) the contract was intended for the plaintiff’s  benefit; and (3) that benefit was direct rather than incidental.  The ISA, however, was not breached.  It did not require SecondMarket to obtain and deliver the legal opinion; that duty was the Facebook employee’s under the STA.  Accordingly, the claim was dismissed.

The court dismissed the claim for negligence because no duty existed.  The court held that the only potential duty was contractual and that a breach of contract claim may be appropriate, but a negligence claim is “improperly duplicative.”

Similarly, Facie Libre’s breach of fiduciary duty claim failed because a fiduciary relationship was never created.  Facie Libre alleged that because it relied on SecondMarket’s expertise, a special relationship of trust, confidence, and responsibility arose that created a fiduciary duty.  The court reasoned that “‘[p]laintiff’s alleged reliance on defendant’s knowledge and expertise . . . ignores the reality that the parties engaged in arm’s-length transactions pursuant to contracts between sophisticated entities that do not give rise to fiduciary duties.’”

The plaintiffs sufficiently pled the elements of an intentional misrepresentation claim.  The elements of an intentional misrepresentation claim are (1) a material misrepresentation; (2) falsity; (3) scienter; (4) reliance; and (5) injury.  SecondMarket allegedly made a “clearly false” statement when it told Facie Libre that the deal had closed, and Facie Libre’s reliance on SecondMarket was reliable because SecondMarket was in the best position to know whether the deal closed.  Finally, Facie Libre properly pled that its injury was proximately caused by SecondMarket’s misrepresentation because if SecondMarket had been truthful, Facie Libre could have obtained the legal opinion, closed the deal, and realized the gain in Facebook’s stock price.

Facie Libre withdrew its professional malpractice claim during oral argument.

Facie Libre’s claim for unjust enrichment was also dismissed.  A successful claim of unjust enrichment alleges a benefit conferred upon the defendant that the defendant obtained without adequately compensating the plaintiff.  Facie Libre’s claim failed because the benefit conferred on SecondMarket came from the Facebook employee, not Facie Libre. 

The primary materials for this case may be found on the DU Corporate Governance website.


Americas Mining Corp. v. Theriault: Delaware Supreme Court Upholds Court of Chancery’s Award for $2 Billion in Damages and $304 Million in Attorneys’ Fees

In Americas Mining Corp. v. Theriault, Nos. 29, 2012, 30, 3012, 2012 LEXIS 459 (Del. Aug. 27, 2012), the Supreme Court of Delaware upheld the Court of Chancery’s judgment in favor of minority shareholders, affirming an award of more than $2 billion in damages and more than $304 million in attorneys’ fees.

Michael Theriault, trustee for Theriault Trust, brought a derivative suit on behalf of minority shareholders in Southern Copper Corporation (“Southern Peru”) against American Mining Corporation (“AMC”), a subsidiary of Southern Peru, and Southern Peru’s affiliate directors for breach of the duty of loyalty. Theriault alleged that AMC, a subsidiary of Grupo Mexico, the controlling shareholder of Southern Peru, caused Southern Peru to acquire a 99.15% equity interest in Minera Mexico (“Minera”), a Mexican mining company owned by Grupo Mexico. Plaintiff alleged that Southern Peru overpaid for the acquisition.

The Court of Chancery held that evidence presented at trial demonstrated that because of the Special Committee’s ineffective operation, AMC, through its controlling shareholder Grupo Mexico, “extracted a deal that was far better than market” price, constituting a breach of the duty of loyalty to Southern Peru. The defendants appealed the decision based on five distinct arguments, and the Delaware Supreme Court found each contention to be without merit.

Defendants argued that the Court of Chancery unfairly prejudiced them when it denied their request to allow one of their financial advisors from Goldman Sachs to testify at trial as a replacement for a previously identified witness. The advisor would explain the internal processes used at Goldman Sachs to issue fairness opinions to clients. The witness was proposed a week before the trial, was not available to be deposed before the trial and was not available to testify during the scheduled trial dates. Defendants requested that he be deposed after every other trial witness had testified, and sought a modification of the trial schedule so that the court could reconvene several weeks after the trial was scheduled to conclude to hear the testimony of the witness.

The Court of Chancery found that other Goldman Sachs witnesses had been deposed about the same topic. Moreover, the trial judge was willing to “watch the video” of the previously identified witness. Finally, the “eleventh-hour request” to change the trial dates “would have been unfair to the Plaintiff.” The Delaware Supreme Court found that the Chancery Court’s decision was “supported by the record and the product of a logical deductive reasoning process” and was, as a result, a proper exercise of discretion.

Defendants also asserted as error the decision of the Court of Chancery to fail to decide before trial which party had the burden of proof. The defendants asserted that their use of a Special Committee resulted in plaintiffs having the burden. The Delaware Supreme Court, however, noted that the shift in the burden depended upon the effectiveness of the Special Committee, something that could only be determined after the presentation of affirmative evidence at the trial. Moreover, the practical effect of the shift in the burden was “slight” and did not, in the opinion of the Court, alter the outcome of the decision. See Id. (“Nothing in the record reflects that a different outcome would have resulted if either the burden of proof had been shifted to the Plaintiff, or the Defendants had been advised prior to trial that the burden had not shifted.”).

The defendants also challenged the lower court’s finding that there had not been fair dealing or fair price. In particular, defendants argued that the Chancery Court incorrectly rejected Goldman Sachs’ valuation procedure without a sufficient evidentiary basis. The Delaware Supreme Court held that “the Court of Chancery did understand the [d]efendants’ argument and that its rejection of the [d]efendants’ ‘relative valuation’ . . . was the result of an orderly and logical deductive reasoning process that is supported by the record.”

The Delaware Supreme Court also reviewed the calculation of damages. In determining the amount of the overpayment, the Court of Chancery looked to three different alternate valuation techniques for Minera, concluding that the average “difference” was $1.347 billion. The court awarded that amount plus the statutory interest rate. Because the Court of Chancery had “explained the reasons for its calculation of damages with meticulous detail” and shared with the defendants “complete transparency of its actual deliberative process,” it properly exercised its discretion in calculating and awarding damages.

Finally, the defendants contended that the $304 million award for attorneys’ fees was unreasonable as it would pay the plaintiffs’ counsel at a rate of more than $35,000 per hour, an amount 66 times more than the value of the attorneys’ time and expenses. The Delaware Supreme Court affirmed the use of the “percentage of the fund” method when setting common fund fee awards. See Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del. 1980) (fees based on (1) the benefit achieved; (2) counsel’s time and effort; (3) the difficulty and complexity of litigating the case; (4) whether counsel’s representation was contingent; and (5) the standing and ability of counsel working on the case).

The Delaware Supreme Court explained that the “benefit achieved” factor was the most important in determining the amount of fees and that counsel, when it secures an extraordinary benefit for its clients, is “entitled to a fair percentage of the benefit” [emphasis in original]. Again, the Court of Chancery described in thorough detail its reasoning for awarding the amount of attorneys’ fees that it did, even declining the percentage based in part upon the size of the judgment, and in part upon plaintiffs’ counsels’ delay in litigating the case.

In an unusual move, Justice Berger filed a separate opinion concurring in the merits of the case, but dissenting with regard to the legal standard applied by the trial court to the award of attorneys’ fees. Justice Berger found that instead of applying the Sugarland factors, the trial court’s analysis was based upon its views of whether the fees available to plaintiffs’ lawyers were high enough to incentivize them to try “mega” cases.

The primary materials for this case may be found on the DU Corporate Governance website.


UBS Financial Services Inc. v. Carilion Clinic: FINRA Arbitration Ordered in ARS Case

In UBS Financial Services Inc. v. Carilion Clinic, Civil Action No. 3:12cv424–JAG, 2012 WL 3112010 (E.D. Va. July 30, 2012), the United States District Court for the Eastern District of Virginia denied plaintiffs’ motion for a preliminary injunction prohibiting arbitration with the Financial Industries Regulation Authority (“FINRA”).

Defendant Carilion Clinic (“Carilion”) is a non-profit healthcare organization operating eight hospitals in Virginia. It entered into a business relationship with UBS Financial Services (“UBS”) and CitiGroup Global Markets, Inc. (“Citi”) (collectively, “Plaintiffs”) through two sets of documents: the Underwriter Agreements and the Broker-Dealer Agreements. Carilion then issued about $234 million in auction rate securities (ARS), allegedly at the recommendation of UBS and Citi, to fund expansion of its facilities. ARS “are bonds for which the variable interest rate is determined through a periodic auction.”  UBS and Citi allegedly bid in these auctions along with investors to ensure the auctions did not fail. When the ARS market crashed in 2008, UBS and Citi discontinued auction bidding; the auctions failed, resulting in a loss of millions of dollars by Carilion. Carilion initiated arbitration in FINRA in February 2012.

In order to be successful on their motion for a preliminary injunction, Plaintiffs must prove the following: “(1) they are likely to succeed on the merits; (2) they are likely to suffer irreparable harm in the absence of preliminary relief; (3) the balance of equities tips in [their] favor; and (4) an injunction is in the public interest.”

Plaintiffs first argued that Carilion is “an issuer of securities, not a customer,” and therefore, Carilion did not have a right to arbitration under FINRA. The court defined “customer” as “one that purchases some commodity or service.” The court reasoned that Carilion was a customer because it paid for financial services, such as underwriting, administrative auction fees, and financial advice. Accordingly, the court ruled that Plaintiffs were not likely to succeed on the merits of arguing Carilion was not a customer.

Next, Plaintiffs argued that Carilion waived any right to arbitration by agreeing to a forum selection clause in the Broker-Dealer Agreements. The court stated that the Federal Arbitration Act “requires any ambiguities in contract to be resolved in favor of arbitration.” The court found that the language of the forum selection clause stated that “all actions and proceedings” were to be brought in New York and it “did not directly address arbitration.” Plaintiffs were also on notice of a potential arbitration requirement because their status as FINRA members required arbitration in certain circumstances. Accordingly, the court ruled that Plaintiffs were unlikely to succeed on the merits of their claim that the forum selection clause waived arbitration.

The court also found that Plaintiffs could not show they would be irreparably harmed, the balance of equities was not in Plaintiffs’ favor, and the public interest favored arbitration.

The primary materials for this case may be found on the DU Corporate Governance website.


Kiobel Unlikely to Turn on Corporate Personhood posted an article this past Monday with the provocative headline: In Shell Case, Will Supreme Court’s View of Corporate Personhood Mean Liability for Crimes Abroad?  The article went on to describe the case as follows:

The Supreme Court opens its 2012-2013 term today with a landmark case to decide whether survivors of human rights violations in foreign countries can bring lawsuits against corporations in U.S. courts. The case centers on a lawsuit that accuses the oil giant Shell’s parent company, Royal Dutch Petroleum, of complicity in the murder and torture of Nigerian activists. Some legal analysts are comparing this case, Kiobel v. Royal Dutch Petroleum, to the landmark campaign finance ruling in Citizens United. In 2010, the Supreme Court ruled corporations have broad rights under the First Amendment and can directly fund political campaigns. The court is now being asked to decide if corporations have the same responsibilities as individuals for violations of international law.

However, there are good reasons to believe the Court will never reach the issue of corporate theory or personhood.  To begin with, the Court ordered re-argument to address the question whether the Court should be hearing the case at all—independent of any questions of corporate status.  As the Wall Street Journal reported (here):

Initially, the Supreme Court agreed to consider whether the alien tort law applied to corporations as well as individuals, but after a first round of arguments in February, the justices ordered additional arguments over the far broader question of whether the law applies at all to events overseas.

"Why does this case belong in the courts of the United States when it has nothing to do with the United States other than the fact that a subsidiary of the defendant has a big operation here?" said Justice Samuel Alito, who both Monday and in February seemed most inclined to restrict the law's scope.

Furthermore, as I note in the latest SSRN draft of my paper, The Silent Role of Corporate Theory in the Supreme Court’s Campaign Finance Cases, 15 U. PA. J. CONST. L. __ (forthcoming), even the corporate-status issue is unlikely to involve corporate personhood/theory:

Looking ahead, in Kiobel v. Royal Dutch Petroleum Co., the Court will soon be addressing the question whether federal courts in the United States may exercise jurisdiction over corporations pursuant to the Alien Tort Statute, which gives federal courts “original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.”   The Second Circuit, in ruling on the case below, identified the relevant issue as “the treatment of corporations as a matter of customary international law.”    This may at first blush suggest corporate theory is irrelevant because the question is not why corporations are treated a particular way under international law, but rather simply how they are in fact treated.  

I did go on to note, however, that:

Nevertheless, it may again be difficult to separate a conclusion about the scope of the statute from preconceived notions about what corporations are.  For example, the Brief Amicus Curiae for the Brennan Center for Justice at NYU School of Law in Support of Petitioners  notes the following:

"In his opinion denying rehearing, a distinguished member of the panel majority below asserted that requiring multinational corporations to defend against customary international law claims in United States courts would subject them to 'extort[ed]' settlements, and unjustifiably 'beggar' them. Such a canard is deeply troubling, not only because it is so clearly legislative in nature, but because it is premised on an indefensible assumption that corporations are freestanding entities less prone to great evil than the fallible human beings who constitute them."

Thus, it is unlikely that the case will turn on corporate personhood or corporate theory, but I won’t be surprised if the attitudes of the justices toward corporations make their way into the opinion nonetheless.



SEC v. Bartek: Officer/Director Bans Barred by Statute of Limitations

In SEC v. Bartek, the Fifth Circuit Court of Appeals held that the discovery rule exception does not apply to the federal statute of limitations (codified at 28 U.S.C. § 2462), and that an injunction permanently barring defendants from serving as officers or directors at any public company is a penalty under § 2462.  2012 WL 3205446 (Fifth Cir. Aug 7, 2012).  The court held that because there was no discovery rule exception in the statute and because the remedy sought by the plaintiff was a penalty, the claims were barred by § 2462.   

Douglas Bartek was the founder and CEO of Microtune, a company that manufactured silicon tuners.  Nancy Richardson was the general counsel and CFO of Microtune.  In 2008, the Securities and Exchange Commission (“SEC”) brought suit against Bartek and Richardson for violations of the antifraud and books and records provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.

According to the SEC, Bartek and Richardson failed to properly expense backdated stock options granted to officers and employees of Microtune from 2000 to 2003.  Allegedly, Bartek retroactively selected grant dates, using the date of the lowest stock price over the previous two weeks as the supposed option grant date.  The SEC claimed that the alleged backdating scheme caused Microtune to understate over $22.5 million of compensation expenses and overstate income in filings to the SEC.  The SEC sought civil penalties and permanent injunctions barring Bartek and Richardson from serving as officers or directors at any public company. 

Bartek and Richardson filed a motion to dismiss, arguing that the claims were barred by the five-year federal statute of limitations for enforcement of civil penalties.  28 U.S.C. § 2462.  The district court granted the motion.  On appeal, the SEC argued that the discovery rule exception should apply to § 2462 and therefore that the claims did not begin to accrue until the SEC first discovered the violations in 2003.  Application of the discovery rule means that a claim begins to accrue “upon discovery of harm” instead of when the violation occurred. 

To determine whether the discovery rule applied to § 2462, the Fifth Circuit considered the text of the statute and case law.  The court found no support for a discovery rule exception in the text of § 2462.  With respect to case law, the Fifth Circuit court began its analysis by noting that it had previously held that “[i]t is abundantly clear that both the courts and Congress have construed the ‘first accrual’ language of § 2462 to mean the date of the violation.”  (citing United States v. Core Labs., Inc., 759 F.2d 480, 482 (5th Cir. 1985)).  The court also noted that the 9th, 11th, and D.C. Circuits have “similarly held that § 2462 does not incorporate a discovery rule.”  Finally, the court applied the Supreme Court’s holding that “the general meaning of when a right accrues is when that claim comes into existence.  (citing United States v. Lindsay, 346 U.S. 568, 569 (1954)).  Thus, the court ruled that the discovery rule did not apply to § 2462. 

The SEC also argued that the permanent officer and director bars it sought against Bartek and Richardson were not penalties, but were instead equitable remedies.  Equitable remedies, unlike penalties, are not subject to the time limitations of § 2462.  The court explained that “[i]n determining whether the sanction is a penalty [under § 2462], a court must objectively consider the degree and extent of the consequences to the subject of the sanction.”  The court found that the injunctions were penalties because they “would have a stigmatizing effect and long-lasting repercussions” and because they wouldn’t remedy past harm.  Therefore, the SEC’s permanent injunction claims against Bartek and Richardson were subject to the time limitations of § 2462. 

Because there was no discovery rule exception to § 2462 and because the injunctions sought by the SEC were penalties, the court affirmed the dismissal of the SEC’s claims against Bartek and Richardson.

The primary materials for this case may be found on the DU Corporate Governance website.


Abrams v. Wainscott: Derivative Action Dismissed

In Abrams v. Wainscott, et al., Ruth Abrams (“Plaintiff”) filed a derivative action in federal district court against the board of directors of AK Steel Holding Corp. (collectively, “Defendants”).  No. 11-297-RGA, (D. Del. August 21, 2012).  

Plaintiff alleged that the proxy statement for AK Steel instructed stockholders that if they voted to reapprove the performance goals of the Long-Term Performance Plan (“LTPP”), the Stock Incentive Plan (“SIP”), and the amendment and restatement of the SIP, performance based compensation under the plans would be tax-deductible.  Plaintiff alleged that the compensation under the plans was not tax-deductible and that the disclosure was misleading.  Plaintiff brought four claims, including unjust enrichment, waste based on the payment of non-deductible compensation, breach of duties under the federal proxy rule, and breach of the duty of loyalty. 

Defendants moved to dismiss the complaint for the failure to make demand.  Plaintiffs asserted, however, that demand was excused as futile.  Under Delaware law, demand futility will be shown through allegations of particularized facts that create a reasonable doubt as to whether “(1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).

The court found that Plaintiff did not adequately allege that the Director Defendants were interested in the various plan matters submitted to shareholders for approval.  As a result, demand would be excused only if Plaintiff alleged particularized facts establishing “a reasonable doubt as to whether the protections of the business judgment rule” were available to the directors.   

Plaintiff asserted that the Compensation Committee of the Board had been responsible for the development and implemented the LTPP.  Moreover, the Committee had, “at various earlier times allegedly violated the express terms of then-existing LTPP.”  Because at least half the board sat on the Compensation Committee, according to Plaintiff, they could not claim the protection of the business judgment rule. 

 The court held that broad allegations of a violation of a compensation agreement was not sufficient to meet the second prong of the Aronson test.  Instead, shareholders had to include allegations of knowledge and intent with respect to the violations of the plan.  Plaintiff also alleged that demand was excused because the majority of the board violated public policy, the claim involved a disclosure issue, and the compensation at issue involves waste. The court summarily dismissed these arguments.

Plaintiff’s pleadings failed under both the first and second prongs of the Delaware test; thus, the court dismissed the case.  The court did so without prejudice in order to allow Plaintiff the chance to amend.

The primary materials for this case may be found on the DU Corporate Governance website.


Securities Fraud and a Pump-and-Dump Scheme: SEC v. Curshen

In SEC v. Curshen, No.11–CV–20561–JLK, 2012 WL 3755527 (S.D. Fla. Aug. 28, 2012), the United States District Court of the Southern District of Florida granted the Security and Exchange Commission’s (“SEC”) motion for summary judgment against two defendants, Yitzchak Zigdon, an accountant, and Ariav Weinbaum, a businessman, for violations of the antifraud provisions in both the Securities Exchange Act of 1934 and Securities Act of 1933.

This case involved the sale of common stock in a limited private company incorporated in the United Kingdom called CO2 Tech (“CO2” or “the company”).  According to the SEC’s allegations, the company had a registered business address in London and purported to have a manufacturing and research development facility in Israel. The company claimed that it had experts with over a decade of experience in the pollution control industry and partnerships/alliances with leading companies and research institutions.   

In reality, according to the SEC, CO2’s London office was simply a rented mail drop, and its manufacturing and research development facility could not be located. Additionally, with respect to the officers, the CEO “had not traveled outside of Israel since November 1, 2003” and the President was the CEO’s 72-year-old mother. 

Sections 10(b) and 10b-5 of the Exchange Act and Section 17(a) of the Securities Act prohibit certain types of false statements.  They also prohibit schemes to defraud.  The latter type of violation did not necessarily require a misstatement or omission, but was aimed at a “broader fraudulent scheme.”

The court found that there were no facts in dispute and that the SEC had met its burden establishing violations of Section 17(a) and Rule 10b-5.  According to the opinion:

A pump-and-dump stock scheme is a classic violation of these provisions. The actions of Defendants . . . repeatedly violated the anti-fraud provisions of the Securities Act and Exchange Act. Defendants . . . converted C02 Tech into a public company by instructing Defendant Krome to find a public shell corporation; opened a brokerage account at Red Sea management to facilitate the stock manipulation; and directed matching buy and sell orders to artificially inflate C02 Tech's stock value. Individually, Defendant Weinbaum transferred money to Defendant Krome for the shell purchase and hired Defendant Weidenbaum to promote the stock and help organize buy and sell orders. Defendant Zigdon orchestrated the false media campaign surrounding C02 Tech.

The court also found the defendants liable for the sale of unregistered securities under section 5 of the Securities Act. According to the court, the SEC produced undisputed facts showing CO2 sold unregistered shares and that the defendants were “at the very least, necessary participants and substantial factors” in the sale of the shares.

The primary materials for this case may be found on the DU Corporate Governance website.


BofA, Merrill Lynch and the Financial Crisis of 2008

BofA settled the law suit over the Merrill Lynch acquisition for $2.43 billion (along with some governance changes). See Bank of America Settles Suit Over Merrill for $2.43 Billion. The suit arose out of allegations that BofA did not adequately disclose a forecast of the fourth-quarter losses expected to be incurred by Merrill.  The action was described as “the largest securities class-action lawsuit settlement yet to arise from the financial crisis.” 

We have no comment on the merits of the case.  We note only this.  The acquisition of Merrill came at a critical time. Lehman had collapsed. The financial markets were hardly functioning. As evidence of the burgeoning losses at Merrill became clear, BofA had an argument that it could walk away from the acquisition (based upon a material adverse condition). There is some evidence that the government pressured BofA to complete the acquisition. Had the Bank walked away and had Merrill collapsed, the blow to the financial markets likely would have been enormous, potentially making the downward economic spiral substantially worse. 

This is one of those instances where the merits of the acquisition to shareholders can be debated (although as the Dealbook article notes, Merrill has contributed “roughly half the bank’s revenue since 2009”). But the financial system, the country, and the persons who would have suffered had the recession worsened as a result of a failure of Merrill, likely owe a debt of gratitude to BofA for completing the acquisition. 


Another Say on Pay Suit Dismissed: Swanson v. Weil

In Swanson v. Weil, the federal district court in Colorado dismissed another case seeking to establish a breach of fiduciary obligations at least in part based upon a negative say on pay vote.  This case involved the board of directors of Janus Capital, a company that received a negative vote on pay in 2011.  As has been the case for most of these suits, the decision was issued in the context of a motion to dismiss for failure to make demand. 

The court found first that the plaintiffs had not alleged sufficient facts to meet the Aronson test.  The facts were not sufficient to show that the board was interested because of the potential for liability arising out of the litigation.  In doing so, the decision noted the holding in NECA-IBEW Pension Fund ex rel. Cincinnati Bell, Inc. v. Cox, No. 11-cv-451, 2011 WL 4383368 (S.D. Ohio Sept. 20, 2011), but found the decision not to be "persuasive." 

In addressing the negative shareholder vote on executive compensation, the court emphasized that "Dodd-Frank expressly states, however, that such a vote may not be construed 'to create or imply any change' to existing fiduciary duties."  The court also rejected the argument that the "resounding no vote" by shareholders combined with a decline in share prices sufficied to remove the presumption of the business judgment rule. 

[the argument] contradicts the express language of Dodd-Frank and well-established Delaware law. Dodd-Frank states that a shareholder vote does not “overrul[e]” a decision by a board or “create or imply any additional fiduciary duties” to rescind or otherwise respond to a say on pay vote. See 15 U.S.C. § 78n-1(c). . . . I also note that the result of the advisory say on pay vote cannot rebut the business judgment presumption because it occurred after the Board approved the 2010 executive compensation. Delaware law forbids using events subsequent to the challenged action to second guess a board’s business judgment.

The decision, therefore, continues a clear trend with respect to legal challenges involving negative say on pay votes.  With the exception of Cincinnati Bell, courts have not been willing to allow cases involving a negative say on pay allegation to get past the demand excusal stage.  Some have used language that suggests a negative vote is irrelevant to the analysis, mostly relying on the language in the statute stating that the advisory vote does not alter fiduciary obligations.  See 15 U.S.C. § 78n-1(c).  A few cases have noted that a negative vote can be a factor in determining whether the board is entitled to presumption of the business judgement rule but, standing alone, does not suffice to rebut the presumption. 

The short term consequences of these decisions is to remove some of the legal risk associated with negative say on pay votes by shareholders.  Boards in general can be comforted by knowing that the fact alone does not significantly increase the risk of a violation of the board's fiduciary obligations.

In the long term, however, the cases likely will make advisory votes less effective.  Aware that a negative say on pay vote does not significantly increase risk, boards will have greater freedom to ignore them.  To the extent that this occurs, advisory votes will have less impact on the compensation process.  In countries where say on pay has not had the intended effect on compensation practices, countries have sometimes put in place second generation statutes that provide shareholders with some binding authority.  This has occurred, for example, in Britain. 


Bill Moyers on “The United States of ALEC”

The following is excerpted (under a Creative Commons license) from “The United States of ALEC: Bill Moyers on the Secretive Corporate-Legislative Body Writing Our Laws,” available on here.

Democracy Now! premieres "The United States of ALEC," a special report by legendary journalist Bill Moyers on how the secretive American Legislative Exchange Council has helped corporate America propose and even draft legislation for states across the country. ALEC brings together major U.S. corporations and right-wing legislators to craft and vote on "model" bills behind closed doors. It has come under increasing scrutiny for its role in promoting "stand your ground" gun laws, voter suppression bills, union-busting policies and other controversial legislation. Although billing itself as a "nonpartisan public-private partnership," ALEC is actually a national network of state politicians and powerful corporations principally concerned with increasing corporate profits without public scrutiny....

BILL MOYERS: ALEC is a nationwide consortium of elected state legislators working side by side with some of America’s most powerful corporations. They have an agenda you should know about: a mission to remake America, changing the country by changing its laws one state at a time. ALEC creates what it calls "model legislation," pro-corporate laws … that its members push in statehouses across the country. ALEC says close to a thousand bills, based at least in part on its models, are introduced every year, and an average of 200 pass. This has been going on for decades, but somehow ALEC managed to remain the most influential, corporate-funded political organization you had never heard of …. Lisa Graves, a former Justice Department lawyer, runs the Center for Media Democracy. That’s a nonprofit investigative reporting group in Madison, Wisconsin. In 2011, by way of an ALEC insider, Graves got her hands on a virtual library of internal ALEC documents. …

LISA GRAVES: Bills to change the law to make it harder for Americans to vote, those were ALEC bills. Bills to dramatically change the rights of Americans who are killed or injured by corporations, those were ALEC bills. Bills to make it harder for unions to do their work were ALEC bills. Bills to basically block climate change agreements, those were ALEC bills….

BILL MOYERS: It sounds like lobbying. It looks like lobbying. It smells like lobbying. But ALEC says it’s not lobbying. In fact, ALEC operates not as a lobby group but as a nonprofit, a charity. In its filing with the IRS, ALEC says its mission is education, which means it pays no taxes and its corporate members get a tax write-off. Its legislators get a lot, too….

STATE REP. STEVE FARLEY: I just want to emphasize, it’s fine for corporations to be involved in the process. Corporations have the right to present their arguments. But they don’t have the right to do it secretly. They don’t have the right to lobby people and not register as lobbyists. They don’t have the right to take people away on trips, convince them of it, and send them back here, and then nobody has seen what’s really gone on and how that legislator has gotten that idea and where is it coming from.

BILL MOYERS: Farley has introduced a bill to force legislators to disclose their ALEC ties, just as the law already requires them to do with any lobbyist.

STATE REP. STEVE FARLEY: All I’m asking in the ALEC Accountability Act is to make sure that all of those expenses are reported as if they are lobbying expenses, and all those gifts that legislators received are reported as if they are receiving the gifts from lobbyists, so the public can find out and make up their own minds about who is influencing what.

BILL MOYERS: Steve Farley’s bill has gone nowhere. ALEC, on the other hand, is still everywhere, still hiding in plain sight. Watch for it coming soon to a statehouse near you.

PS--Relatedly, you might find my article "Finding State Action When Corporations Govern" of interest.


Universal Banks, Market Risk and Efforts to Have It Both Ways

The Economist opposes the break up of large banks but is also critical of some of the regulatory limitations gradually being imposed on these financial institutions.  The two positions, in the messy real world, have an air of inconsistency.  

What are the arguments for leaving the size of large financial institutions untouched?  According to the Economist, there are three reasons why some favor a break up of the large banks:  there is something rotten about investment banking that infects commercial banking; there is a threat to financial stability because of the added complexity that comes with size and involvement in the securities markets; and universal banks "are a dreadful deal for investors."

Having defined the problem in a particularly inapt way, the Economist then demolishes each of its own characterization.   As it notes:  "The idea that all finance’s problems stem from the investment-banking 'casino' is a misdiagnosis."   But of course no one says that all problems in finance stem from involvement in the securities markets, only that involvement increases risk. 

What about financial stability?  The main argument is that involvement in securities markets permits commercial banks to diversify their investment portfolio, with a mix of loans and securities activities.  That is, of course, true, but it does not in any way assess the risks associated with particular types of investments.

As for the "dreadful deal" for investors, the article simply noted that this was "open to question."  Perhaps.  But isn't the issue a bit broader than that?  If we were only concerned about investors, there would be no problem with "too big to fail."  Let them fail and wipe out the equity holders.  Too big to fail is decidedly not a doctrine focused on investors but the impact of a failure on the financial system. 

Finally, the Economist did note that while "it is easy to call for banks to be carved up, it would be hellishly difficult in practice."  True.  But that goes to execution (no small matter).  It is not a commentary on the broader issue of whether a break up should occur.  Thus, the comment that they should not be broken up because "most are so large that simply slicing them in two would not solve the problem" begs the question of how deep to slice in any downsizing endeavor. 

Nonetheless, recognizing the problem of too big to fail, the Economist noted the proposal by the British Government to adopt a "ring fence" around retain and investment banking activities.  As the article noted: 

that would force the retail and investment-banking arms of universal banks to have their own capital buffers, shielding depositors from losses in the investment bank but retaining some diversification benefits. Add in new rules requiring all types of banks to hold more capital, and (crucially) efforts to impose losses on private creditors of a failing institution, and the case for radical surgery is blunted.

Put aside the logistical issues that would arise in connection with the implementation of such a scheme.  The solution of the Economist was do not downsize, but increase regulation.  

But having proposed additional regulation in place of downsizing, it did not take the Economist very long to criticize efforts to increase the regulatory framework for investment banks.  In a subsequent article, the Economist noted the inevitable consequences of increased regulation, a decline in profitability.  

regulations on capital and liquidity are starting to bite. These are reducing returns earned by banks as well as forcing them to shrink their balance-sheets and cut back on trading. Many banks are also starting to position themselves for proposed rules that are not yet in force, such as America’s Volcker rule, which aims to stop banks trading for their own account, and regulations that will shove over-the-counter derivatives, which command fat margins, onto clearing-houses and exchanges.

So regulation designed to more tightly regulate investment banking activities is starting to hurt, at least when measured by profitability.

It is a set of arguments that seek to have it both ways.  Start with the presumption that banks are in fact too big to fail.  Why?  The NYT Magazine said it nicely: 

The main lesson of Lehman’s collapse is that the response to a troubled financial system is, ultimately, determined not by technical regulation, but by politics. The F.D.I.C. can use its new powers only after receiving the consent of the Treasury secretary. And its new powers pertain only to those banks deemed systematically important, a designation determined by political appointees. So while the F.D.I.C. is working to formalize the rules governing its new powers, investment-bank lobbying has grown by nearly 60 percent since the crisis began. Bankers learned that they need to be closer than ever to politicians.

So there really are only two solutions.  One is to downsize the banks and make them small enough that they can fail without creating a political question.  The second is to increase the regulation of universal banks, not because it is good for investors, not because it makes the financial system more stable over all, but because it reduces the risk profile of universal banks and makes a failure less likely, reducing the instances of a possible failure. 

This is not an argument for either position.  Both solutions are difficult to implement and will cause plenty of problems.  It is mostly a commentary on those who seem to argue against both approaches.  There is a viable basis for doing so:  that too big to fail is a reality and should simply be accepted.  But to the extent there is concern with too big to fail, they can at least be ameliorated through adjustments in size and/or adjustments in risk.  For more thoughts on this subject, see The "Great Fall": The Consequences of Repealing the Glass-Steagall Act


Federal Housing Finance Agency v. The Royal Bank of Scotland: The Private Securities Litigation Reform Act is not Applicable to the Federal Housing Finance Agency

The Federal Housing Finance Agency (“FHFA) brought a claim as a conservator for the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) against The Royal Bank of Scotland (“RBS”) and multiple other defendants, alleging violations of federal securities laws.  Defendants sought to invoke the automatic stay of discovery contained in the Private Securities Litigation Reform Act (“PSLRA”). See 15 U.S.C. § 78u-4(b)(3)(B). The United States District Court for the District of Connecticut ruled that the present claim was not a private action under the PSLRA and, as a result, declined to order a stay of discovery. Fed. Hous. Fin. Agency v. The Royal Bank of Scotland Group PLC, No. 3:11-cv-01383 (D. Conn. Aug. 17, 2012).

Fannie Mae and Freddie Mac were formed in order to “make the secondary mortgage market more competitive and efficient.” Both companies are federally chartered. In 2008, Congress created the FHFA and gave it the power to place regulated entities into conservatorship. In 2008, the FHFA became the conservator for Fannie Mae and Freddie Mac for the purpose of stabilizing the two corporations.

In the action brought by FHFA, the defendants filed a motion to dismiss while the plaintiff filed a motion to commence discovery.  In response to plaintiff's motion, defendants sougth a stay of discovery, noting that under the PSLRA, “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss . . .”  The defendants asserted that because the plaintiff stepped into the shoes of two private corporations, it had become a private plaintiff.  As a result, plaintiff’s action was private, subject to the PSLRA, and subject to the stay of discovery. 

In resolving the applicability of the PSLRA, the court reasoned that “the material distinction for purposes of determining whether an action is a ‘private action’ under the PSLRA is the nature of the plaintiff, not the cause of action.” Thus, the PSLRA applied to actions brought by private plaintiffs, but not those brought by government agencies, such as the Securities and Exchange Commission. The court concluded that the FHFA, did not lose its status as a government agency simply by acting as a conservator for private parties.

In the alternative, the defendants argued that Rule 26(c) of the Federal Rules of Civil Procedure required a stay of discovery during this time period. However, the court ruled that the defendants had not met their burden of “showing that good cause exists” to justify an order to stay the plaintiff’s discovery.

The primary materials for this case may be found on the DU Corporate Governance website.


Auto. Indus. Pension Trust Fund v. Textron Inc.: Pleading Fails To Meet the Scienter Element Under Heightened PSLRA Standards

On June 7, 2012, the First Circuit Court of Appeals affirmed the district court’s decision to grant Textron Inc.’s (“Textron”) motion to dismiss Appellees’ securities fraud class action claim.  Auto. Indus. Pension Trust Fund v. Textron Inc., No. 11-2106, 2012 WL 2038098 (1st Cir. 2012).  Automotive Industries Pension Trust Fund was the lead appellee for a class of plaintiffs (collectively, “Appellees”) who invested in Textron.

According to the complaint, Textron, which wholly owns Cessna Aircraft Company (“Cessna”), made statements over the course of 2007 and 2008 assuring its investors of its financial strength due to the depth of its backlog of orders at Cessna.  For instance, Textron allegedly stated that the backlog would carry the company through difficult economic times.  For sixteen months leading up to January 2009, Textron management reassured investors that its backlog was resilient and cancellations were minimal.  On January 29, 2009, however, Textron reported a disappointing fourth quarter in 2008, with “few orders, 23 cancellations, and ‘an unprecedented number of deferrals’ of delivery dates by customers.”  After the report’s release, Textron stock declined thirty-one percent. 

To allege a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5,  plaintiffs must plead “1) material misrepresentation or omission; 2) scienter; 3) a connection to the purchase or sale of a security; 4) reliance on the representations; 5) economic loss; and 6) loss causation.”  To reduce the number of securities lawsuits, Congress enacted the Private Securities Litigation Reform Act (“PSLRA”), which requires plaintiffs to allege each specific misleading statement, state why it is misleading, and allege a “strong inference” that the defendant acted with scienter.  Adequate scienter is the “intent to deceive, manipulate, defraud” or act recklessly with an indifference to deceit.

Appellees’ claim relied on twenty-three confidential witnesses who allegedly revealed weaknesses in Cessna’s backlog.  The weaknesses included lowered credit standards for buyers, customer deposits that Cessna fully financed, and generous loan repayment terms.  Cessna encouraged customers to delay their orders instead of canceling them; additionally, many customer orders were contingent, intended only to be delivery placeholders and not actual orders.  Appellees alleged that Textron made false statements about cancellation figures, including an announcement that Cessna had only two cancellations as of July 2008.   Appellees’ main claim, however, was that Textron failed to disclose information about the weakness of its backlog orders.

The court held that Appellees’ complaint failed to plead facts sufficient to infer scienter.  Nothing in the complaint implied that Textron’s management believed, or was reckless in not knowing, that the backlog had been compromised by loose underwriting standards.  Allegations that Textron’s management was unaware of Cessna’s unstable backlog would establish negligence, but negligence was not sufficient to prove scienter under PSLRA standards.  The court stated that a concealed change in company policy could support an inference of scienter; however, Appellees did not plead those facts. 

A strong inference of scienter can also arise from stock sales that are unusual in amount.  Appellees highlighted some stock sales by Textron management during the class period, but Appellees did not provide comparative sales from outside the class period to suggest that these were unusual.  Additionally, the confidential witness statements about backlog cancellations occurring “suddenly” in “late summer” corroborated Textron’s statements and did not establish scienter.  None of Appellees’ scienter allegations were sufficient to meet the burden of the PSLRA’s heightened pleading standards; therefore, the appellate court affirmed the dismissal of the claim.

The primary materials for this case may be found on the DU Corporate Governance website.



Koehler on the FCPA

Mike Koehler (SIU) has posted Foreign Corrupt Practices Act Enforcement as Seen through Wal-Mart's Potential Exposure on SSRN with the following abstract:

High-profile instances of Foreign Corrupt Practices Act scrutiny focus attention on the law and its enforcement across a broad spectrum. In spring 2012, arguably the most high-profile instance of scrutiny in the FCPA’s 35-year history occurred as Wal-Mart’s alleged conduct in Mexico dominated the news cycle. Wal-Mart’s scrutiny has been instructive in many ways at a key point in time for the FCPA. This article uses Wal-Mart’s potential FCPA exposure as a prism to view the current FCPA enforcement environment.


Yudell v. Gilbert: Distinguishing Direct and Derivative Claims

In Yudell v. Gilbert, 2012 N.Y. Slip Op. 05896, 2012 WL 3166788 (N.Y. App. Aug. 7, 2012) the Appellate Division of the New York Supreme Court affirmed the dismissal of an action brought by a joint venture, holding that the breach of fiduciary duty claim was derivative, not direct, and the plaintiffs, a few members of a joint venture, failed to plead demand futility with requisite particularity.

In 1965, Baldwin Harbor Associates (BHA) was formed as a joint venture for the purpose of constructing and managing a shopping center. BHA hired Jerrold Gilbert (“Gilbert”) as the managing agent for the shopping center, responsible for billing and collecting rents and maintaining and repairing the premises. Gilbert later became a trustee of one trust set up as the successor venture partner to a deceased partner of BHA.

In 2008, the plaintiffs filed suit against Gilbert as an individual, the other members of BHA, and BHA as a nominal defendant, alleging both direct and derivative claims. On appeal were five causes of action pled by the plaintiffs stemming from Gilbert’s alleged failure to timely and regularly collect additional rents and charges including tax obligations and common area maintenance as required by the leases, and his decision to enter into third-party contracts on behalf of BHA. The specific claims against Gilbert were for his failure to properly account to the joint venture partnership, breach of the management agreement, negligence, breach of the joint venture agreement, and breach of the fiduciary duty he owed to BHA and each of the joint venture partners.

To bring derivative claims, a plaintiff must first make demand on the board of directors. The demand requirement may be waived if it would be futile. Futility will occur where the board is not independent or the decision is not protected by the business judgment rule. The plaintiffs alleged demand futility, but did not plead futility with the required degree of particularity. The plaintiffs argued that the pleading requirement was unnecessary because the fiduciary duty claim was direct rather than derivative.

The court adopted the Delaware framework to determine whether a claim was direct or derivative. This required the court to

look to the nature of the wrong and to whom the relief should go. The stockholder’s claimed direct injury must be independent of any alleged injury to the corporation. The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.

A court should, therefore, look to “(1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually).”

Accordingly, the court held that the plaintiffs’ claim of breach of fiduciary duty was derivative because any loss suffered by the plaintiffs derived from a loss to BHA. Additionally, any recovery on the claims would equal the value of lost rent and charges that would be to the benefit of BHA; the plaintiffs would receive their proportionate share of the recovery after BHA received its recovery and divided it among the members of the entity.

Because the plaintiffs’ failed to sufficiently plead demand futility, the claims were properly dismissed. As the lower court dismissed the claims without prejudice, the plaintiffs would be afforded the opportunity to amend the complaint and refile.

The primary materials for this case may be found on the DU Corporate Governance website.


When in Doubt, Don’t Show Up: DC Circuit Reversed and Remanded SEC’s Default Order in Rapoport v. SEC

In Rapoport v. SEC, the D.C. Circuit Court of Appeals granted petitioner Rapoport’s petition for review, vacated the Security and Exchange Commission’s (“SEC”) default order, and remanded for further proceedings.  The court concluded that the SEC had arbitrarily applied Rule 155(b) of its Rules of Practice and failed to provide a comprehensible standard for what constituted a reasonable time to file a motion to set aside a default.  Rapoport v. SEC, 2012 WL 2298772 (D.C. Cir., June 19, 2012). 

The SEC entered a default judgment against Dan Rapoport (“Rapoport”), a Russian citizen, for failing to respond to administrative proceedings alleging violations of Section 15(a) of the Exchange Act. According to the SEC’s Order Instituting Proceedings (“OIP”), Rapoport “solicited institutional investors in the United States to purchase and sell thinly-traded stocks of Russian companies . . . without registering as a broker-dealer as required by Section 15(a) of the Exchange Act” or meeting an exemption under Rule 15a-6.  17 CFR 240.15a-6. 

Rapoport filed a motion to set aside the default.  Under Rule 155(b) of the Exchange Act, a motion to set aside a default must (1) be made within a reasonable time; (2) state the reasons for the failure to appear or defend; and (3) specify the nature of the proposed defense to the original proceeding. 17 C.F.R. § 201.155(b).  If the SEC finds “good cause shown,” the default can be set aside at any time.

The SEC determined that Rapoport failed to file his motion within a reasonable time and that his reason for failing to defend the OIP lacked merit.  Because the first two prongs of Rule 155(b) were not met, the SEC did not consider the merits of Rapoport’s defenses. 

The court held that by failing to consider Rapoport’s defenses, the SEC departed from its previous interpretation of Rule 155(b) and did so without justifying the inconsistency.  The court stated that “[a]lthough the Commission is not bound to follow its precedent, it may not depart from its precedent without offering a reasoned explanation.”

The DC Circuit also held that the Commission “failed to provide any intelligible standard to assess what constitutes a ‘reasonable’ amount of time for filing a motion to set aside a default order under Rule 155(b).”  It was unclear when the “reasonable time” clock started ticking and what amount of time was reasonable to file a motion to set aside a default after the clock had begun.    

Finally, the court suggested that the SEC review the sanctions it applied in the default judgment.  Rapoport was charged with a second-tier penalty for each year of the alleged violations.  There were, however, no specific allegations of Rapoport’s violations to support the charges. The SEC instead relied on conclusory allegations that Rapoport willfully violated Section 15(a), which alone are not enough to justify maximum second-tier penalties without further explanation.  The court held that the SEC’s further explanation “was not just superficial, it was non-existent.”

The primary materials for this case may be found on the DU Corporate Governance website.


A Brief Comment on Greenfield’s Stakeholder Strategy

Earlier this month, Kent Greenfield published an essay entitled, “The Stakeholder Strategy: Changing corporations, not the Constitution, is the key to a fairer post-Citizens United world.”  In the essay, Greenfield “urges progressives to cease their efforts to amend the constitution to weaken corporate ‘personhood.’”  Instead, he advocates two corporate governance changes:

First, the law of corporate governance should expand the fiduciary duties of management to include an obligation to consider the interests of all stakeholders in the firm…. [S]econd … alter the actual structure of company boards to allow for the nomination and election of board members who embody or can credibly speak for the interests of stakeholders.

Greenfield notes that these two changes would most likely require an additional third change—the [further] federalization of at least some meaningful portion of state corporate law:

In order to make these changes meaningful, they would have to be accomplished in a way that minimizes Delaware’s dominance. Otherwise, companies could avoid these changes by fleeing—on paper—to Dover or Wilmington. The most obvious answer to this problem is an assertion of a national corporate-law standard. If the federal government required, for example, companies of a certain size be chartered as national corporations, it would be simple to add the robust fiduciary duties and the requirement that boards include employee representatives. A national corporate-law standard would be a straightforward application of Congress’s Commerce Clause power even in this era of its parsimonious application.

Greenfield’s essay has much more to offer than these main points, and I highly recommend you go read the whole thing.  However, I did want to note one particular reaction I had in reading his proposals.  

To begin with, the general notion of encouraging corporate boards to consider stakeholders is not new.  In fact, the most recent edition of Klein, Ramseyer, and Bainbridge's Business Associations casebook notes that:

A Pennsylvania provision, enacted in 1990, provides, as part of its rules on duties of directors, that directors ‘‘may, in considering the best interests of the corporation,’’ consider the effects of their actions on ‘‘any or all groups affected by such actions, including shareholders, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.’’ Penn.Consol. Statutes, Title 15, § 102(d).

However, while I believe at least one state had a mandatory stakeholder statute at one time, the permissive nature of the typical stakeholder statute obviously distinguishes Greenfield’s proposal.  Furthermore, granting stakeholders a right of action to enforce the obligation helps negate a typical criticism of more traditional stakeholder statutes, which is that they primarily serve as a further defense for directors against shareholder suit but impose no offsetting accountability. 

Having said all that, what currently intrigues me is thinking about the role of disclosure in all of this.  I believe requiring boards to disclose the substance of their deliberations as to each covered stakeholder could produce an independent benefit.  For example, if every relevant proxy statement included a section entitled “Impact on Employees and Local Communities,” the ensuing debate would likely be enriched and, as Greenfield notes in discussing the board-composition proposal: “Another benefit of requiring corporations to take into account the interests of a broader range of stakeholders in corporate decision-making is that the quality of the decisions themselves will improve.”  Even more provocatively, imagine if this type of disclosure requirement was imposed on political speech decisions.  Corporations could be required to explain how their political spending improves the welfare of each covered stakeholder.  Wouldn’t you like to be a fly on the wall while the advisors tried to craft that disclosure?

Obviously, there will be times (perhaps many) when the the interests of stakeholders conflict, and this is a common criticism of stakeholer statutes that remains relevant to Greenfield's proposal.  However, one possible solution to this problem is to direct boards to resolve all such conflicts in favor of the long-term sustainability of the enterprise.  (Relatedly, David Westbrook just sent around an email to the bizlaw listserv noting an upcoming conference on Rethinking Financial Markets that focuses in part on "Custodial Regulation," which advances the notion that "the practice of financial regulation should shift focus from fostering the formation and allocation of capital to maintaining the stability of the institutions, now all perforce monetary institutions, on which contemporary social life depends.”)

PS--Bainbridge also posted a response to Greenfield's piece here.


Platinum Partners Value Arbitrage Fund LP v. Chicago Board Options Exchange: Regulatory Immunity Does Not Apply to Private Disclosure of a Regulatory Action

In Platinum Partners Value Arbitrage Fund LP v. Chicago Board Options Exchange, No. 1-11-2903 (Ill. App. Aug. 10, 2012), the appellate court reversed the trial court’s dismissal of the plaintiff’s securities and fraud claims, holding that the doctrine of regulatory immunity did not apply to the private disclosure of a stock option price adjustment by a self-regulatory organization (“SRO”).

The plaintiff, a hedge fund, alleged that an unnamed employee at one of the defendants Chicago Board Options Exchange (“CBOE”) or Options Clearing Corporation (“OCC”) disclosed a pending adjustment to the strike price of options in India Fund, Inc. (“IFN”) to insider market participants before making a public disclosure of that adjustment. The plaintiff further alleged that because it purchased 50,000 IFN put options after the private disclosure but before the public disclosure, it was harmed by the defendants’ private disclosure. The trial court dismissed the case, holding that the CBOE and OCC were absolutely immune from suit because the conduct at issue was undertaken as part of their regulatory duties as SROs.

Regulatory immunity applies to allegations concerning conduct “within the bounds of the government functions” delegated to an SRO. The test for whether conduct is within those bounds is objective and depends on whether “specific acts and forbearances were incident to the exercise of regulatory power.” The court reasoned that although the strike price adjustment was itself an exercise of regulatory power, the private disclosure, which served no regulatory purpose, was not. Thus, the private disclosure was not within the scope of regulatory immunity.

The defendants argued that, even absent regulatory immunity, the plaintiffs had failed to state a claim. The court, however, held that the plaintiffs had properly stated a claim of fraud under sections 12(F) and 12(I) of the Illinois Securities Law (which closely tracks federal securities law), the Illinois Consumer Fraud and Deceptive Business Practices Act, and common law. Section 12(F) claims require that “a complainant must allege that the defendant (1) made a misstatement or omission, (2) of material fact, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff reasonably relied and (5) that reliance proximately caused the plaintiff’s injuries.” Here, the defendants had a duty to disclose the strike price adjustment, and the plaintiffs adequately pleaded the requisite omission of that disclosure, materiality, reliance, and injury. In addition, the plaintiffs adequately pleaded the scienter element necessary for the other three claims.

Because the defendants’ private disclosure of the strike price adjustment was not within the scope of regulatory immunity, and because the plaintiffs adequately pleaded four fraud claims, the court reversed the trial court’s dismissal of the plaintiff’s claims. It also held that the plaintiff should be allowed to amend its complaint to include new facts and allegations discovered by its replacement counsel, because it was “in the best interests of justice.”

The primary materials for this case may be found on the DU Corporate Governance website.


Richman v. Goldman Sachs Group: CDOs and Wells Notices

In Richman v. Goldman Sachs Group, Inc., WL 2362539 (S.D.N.Y. June 21, 2012), the court dismissed Plaintiffs' claim regarding Goldman Sachs Group, Inc.’s (“Goldman”) failure to disclose its receipt of Wells Notices but denied Defendants’ motion to dismiss claims pertaining to Goldman’s alleged conflicts of interest in several Collateralized Debt Obligation ("CDOs") placements.

Plaintiffs are purchasers of Goldman's common stock between February 5, 2007 and June 10, 2010 (“Plaintiffs”). Defendants are Goldman Sachs & Co (“Goldman”), Goldman Chairman and CEO Lloyd C. Blankfein, Goldman CFO David Viniar and Goldman COO Gary D. Cohn (“Individual Defendants.”) Plaintiffs claimed that Defendants made misstatements and omissions about Wells Notices the company received from the Securities and Exchange Commission (“SEC”), and about the conflicts of interest arising out of Goldman's role in structuring the CDOs known as Abacus, Hudson Mezzanine Funding ("Hudson"), Anderson Mezzanine Funding ("Anderson") and Timberwolf I.

In the Abacus transaction, for example, Goldman allegedly allowed one of its favored hedge fund clients, Paulson & Co., to select assets for inclusion in the CDO. At the same time, however, Goldman falsely identified ACA Management as the sole portfolio selection agent for the transaction.  Goldman also allegedly told investors that it had "aligned itself with the Hudson program by investing in a portion of equity," while at the same time it failed to disclose that it had the entire short position on the deal (in other words, Goldman did not disclose that its $6 million equity holding in the CDO was dwarfed by the $2 billion short position held in it). Plaintiffs also alleged other examples of undisclosed conflicts.  

The court found that Plaintiffs plausibly alleged that Goldman made material omissions regarding its arrangement with Paulson & Co. in the Abacus transaction because Defendants "knowingly allowed Paulson to select the assets for the Abacus CDO, and knew that Paulson was selecting assets that it believed would perform poorly or fail." Similarly, the court found that Plaintiffs plausibly alleged that in the Hudson, Anderson, and Timberwolf I CDO transactions, Goldman represented that it held a long position in the equity tranches and did not disclose its substantial short positions. As the court said:

 "having allegedly affirmatively represented [Goldman] had a particular investment interest in [these synthetic CDOs]—that it was long—in order to be both accurate and complete, Goldman ... had a duty to disclose [it] had a [greater] investment interest [from its] short [position] ... [because that was] a fact that, if disclosed, would significantly alter the ‘total mix’ of available information."

Finding that Plaintiffs established duty, the court turned to the scienter analysis. Scienter could be  inferred when defendants "knew facts or had access to information suggesting that their public statements were not accurate." Here, Defendants allegedly assured shareholders that Goldman complied with the law and that it had "procedures in place to address 'potential conflicts of interest.'" Alternately, Goldman allegedly fostered a conflict of interest in the Abacus CDO and acted against investor interest in Hudson, Anderson and Timberwolf I. The court found that "Goldman knew or should have known that its statements about complying with the letter and spirit of the law, and its disclaimers regarding ‘potential’ conflicts of interest were inaccurate and incomplete." The court agreed with Plaintiffs that a strong inference of scienter could be drawn from Goldman's actions in the four CDO deals.

The court also found that Plaintiffs had sufficiently alleged loss causation and claims against the Individual Defendants.  The Individual Defendants allegedly helped prepare the SEC filings at issue. Moreover, scienter was established through allegations that the Individual Defendants actively monitored the status of the relevant CDO assets and were intimately acquainted with the CDO operations.    

With respect to the Wells Notices, Goldman, according to Plaintiffs, failed to disclose the receipt of the Wells Notices from the SEC in connection with the investigation of the Abacus transaction.  Plaintiffs asserted that Defendants' disclosures about governmental investigations triggered a duty to disclose receipt of Wells Notices, and that by failing to do so caused the public to mistakenly believe that “no significant developments had occurred which made the investigation more likely to result in formal charges." The court noted that the delivery of a Wells Notice, while reflecting the SEC Enforcement Division’s determination on bringing charges, did not necessarily mean that charges would be filed.  The court found that failure to disclose receipt of the Wells Notices did not render Goldman’s statement misleading and that Defendants' violation of FINRA's Wells Notice disclosure requirement was not grounds upon which a section 10(b) or Rule 10b-5 claim could be based.   The court also rejected the argument that a FINRA rule requiring disclosure of a wells notice triggered a duty to disclose under the antifraud provisions. 

The primary materials for this case may be found on the DU Corporate Governance website


How Women Can Change Corporate Boards: The Effects of Achieving a Critical Mass of Female Directors

This post was co-authored and submitted to The Race to the Bottom by Anna Catalano and Nick Slavin. Ms. Catalano serves on the boards of directors of Mead Johnson Nutrition, Willis Group Holdings, Chemtura, and Kraton Polymers. Her leadership blog can be found here. Mr. Slavin wrote this when he was a corporate attorney with Skadden, Arps, Slate, Meagher & Flom LLP.  

As the number of qualified women in the corporate director candidate pool grows, companies are reconsidering the business case for gender diversity on boards. The most familiar arguments involve the optical value of having a board’s members reflect the company’s diverse employees, customers, shareholders, and other stakeholders, and the strategic value of women’s diverse “perspective” in the boardroom. In recent years, however, the arguments have come into sharper focus as some commentators have made the controversial claim that women may have higher ethical standards in business than do men,[1] and studies have more precisely articulated the benefits women can provide in the boardroom and the circumstances in which such benefits occur. 


Although the causal mechanisms are difficult to pinpoint, the correlations between women directors and ethical governance are beginning to show a pattern. A 2009 study in Corporate Reputation Review found that Fortune 500 companies with higher percentages of women directors were more likely to be found on Ethisphere Magazine’s “World’s Most Ethical Companies” list.[2] Other studies identify a correlation between women directors and higher scores on measures of corporate social responsibility.[3] Data from the Journal of Financial Economics suggest that these positive effects might be due in part to the effects they have on the other board members, showing that a greater number of female directors is correlated with better attendance and engagement of male directors.[4]

Recent research analyzes how boardroom dynamics change as the number of female directors increases. Kramer, Konrad, and Erkut’s (2006) Critical Mass study observes that the benefits of a gender diverse board only fully appear upon reaching a “critical mass,” or tipping point, of women directors.[5] Their research shows that while one woman may have a potential impact in the boardroom, the presence of three or more substantially increases the magnitude of women’s influence. Reaching this threshold number gives women the support and validation they need to be the most effective directors.

In some European countries, reaching this threshold is now mandated. Required gender-based quotas for public company boards have been introduced in Norway, France, Iceland, and Spain, while countries such as Switzerland, Israel and South Africa have introduced quotas for government-owned companies.[6] Norway’s mandated quota, introduced in 2003, called for women to comprise at least 40% of public boards by 2008.[7] Proponents argue that Norway’s model has not adversely affected corporate valuations as some feared, and Norwegian board members interviewed about their experiences report that the markedly increased female presence has at a minimum made preparation material more comprehensive and processes more formal, both of which tend to be associated with good governance.

Solo female directors, however, remain common in the United States. Catalyst, a nonprofit organization that advocates women in business, reports that in 2005, 182 companies in the Fortune 500 had just one female director, while 53 companies still had no female representation on their boards.[8] While strong women can make a substantial difference as solo flyers, those who serve as the lone woman director often report feelings of isolation as fellow board members may view their competence cautiously. Though two women with different styles and areas of expertise can help dispel some feelings of tokenism (particularly if their backgrounds include significant profit-and-loss and financial experience), women who serve on boards with only two female directors say they dislike being stereotyped as the “women’s contingent.”[9] The Critical Mass study indicates that boards that follow the “rule of three” normalize women’s presence in the boardroom, where they are viewed more as contributing individuals rather than as representatives of their gender. In contrast to the Norwegian model, relatively few American companies benefit from this phenomenon: last year, just over one-fifth of companies in the Fortune 500, where average board size is over 11, had three or more women directors.[10]

Moving boards beyond the lone token woman requires companies to see the value of a gender-diverse board, and a number of recent studies have highlighted the benefits of gender diversity. They note that women more often consider multiple stakeholders, not just stockholders, when making decisions, and have a greater connection to the complex human context of the business. According to some, women are more likely to ask tough questions and demand comprehensive answers, and their collaborative leadership style and direct manner of communication can improve board dynamics as well. The Norwegian data also support previous studies observing that boards with more women tend to be more engaged, better prepared, and more observant of formalities.

Still, the subtle and often ambiguous benefits that female directors bring continue to be debated, with many arguing that women directors are not preferable to serve on boards than similarly qualified male candidates. A 2010 study surveying 400 male and female board members of primarily American companies concluded that while 90% of female directors believed women bring unique attributes and perspectives to the boardroom, only about half of male directors shared the sentiment.[11] The same study showed that male directors were less likely than female directors to support the SEC rule mandating an explanation of diversity’s role in board member selection (43% vs. 62%, respectively). Likewise, 25% of surveyed women supported diversity quotas and regulations, while just 1% of men reported so.

Perhaps these differences of opinion in part reflect the reality that with diversity comes potential risks: miscommunication, conflict, exclusion, and loss of camaraderie. Qualified directors must be chosen carefully and the chairman must have the ability to temper the wider range of opinions at the table with an overall sense of group cohesion.

While the benefits of gender diversity on boards remain controversial, recent research, as well as the effects of quotas in certain countries in Europe and elsewhere, have helped to articulate clearer rationales for boards adding strong female directors, at least until a “critical mass” is achieved.

[1] Lisa Yoon, “On Boards, Are Women the Fairer Sex?,”, April 10, 2003. Retrieved from

[2] Bernardi, Richard A., Susan M. Bosco, and Veronica L. Columb, “Does Female Representation of Boards of Directors Associate with the ‘Most Ethical Companies’ List?” Corporate Reputation Review 12.3 (2009): 270-280. Business Source Complete. Web. 13 June 2012.

[3] Bernardi, Richard A., and Veronica H. Threadgill, “Women Directors and Corporate Social Responsibility.” Electronic Journal of Business Ethics and Organization Studies 15.2 (2010): 15-21. Retrieved from

[4] Adams, Renée B., and Daniel Ferreira, “Women in the Boardroom and Their Impact on Governance and Performance.” Journal of Financial Economics 94.2 (2009): 291-309. Elsevier. Retrieved from

[5] Kramer, Vicki W., Alison M. Konrad, and Sumru Erkut, “Critical Mass on Corporate Boards: Why Three or More Women Enhance Governance.” Wellesley Centers for Women 11 (2006): 1-74.

[6] Wintrob, Suzanne, “Mandated Diversity Quotas Won’t Make Corporate Governance Any Better,” Financial Post Magazine, June 19, 2012. Retrieved from

[7] Ibid.

[8] Soares, Rachel, Baye Cobb, Ellen Lebow, Allyson Regis, Hannah Winsten, and Veronica Wojas, “2011 Catalyst Census: Fortune 500 Women Board Directors.” Catalyst (2011): 1-2. Retrieved from

[9] Kramer, Konrad, and Erkut, 30.

[10] Soares et al.

[11] Connor, Michael, “Men and Women Disagree Sharply on Governance.” Business Ethics, October 7, 2010. Retrieved from